Corporate governance failures and ethical violations in Enron Corporation

¶ … organizational governance case study of former energy company, Enron Corporation.

Enron

Interstate pipeline corporation, Enron was engaged in the business of supplying power to utilities ever since its establishment in the year 1985. An InterNorth-Houston Natural Gas merger led to its founding. In the next two decades, the corporation quickly developed into the world's largest energy company. By the end of the 20th century, the company ranked amongst the leading global electricity, communications, and natural gas companies as well as among the most admired companies across the globe (Skilling v. United States, 2010). As competition grew in the years that followed its establishment, the company decided to invest in international markets and diversify, in order to retain its position in the market. However, these activities ended in large unanticipated losses for the company. In the year 1999, after making yet another erroneous decision of venturing into the broadband and fiber optics market, the company accrued too many significant losses and the company started witnessing a rapid downfall. However, Enron made its losses known to the world only in October of 2001.

Governance Issue/Laws

Michael Novak, author of Business as a Calling: Work and the Examined Life, writes in his book that Enron's former Chief Executive and Chairman, Kenneth Lay claimed that he was fully aware of legal, ethical and moral behavior, as well as what these meant from the point-of-view of leading people and organizations. His introductory statement in the revised 64-page-long edition of Enron's ethical code, released in July of 2000, indicates that employees and managers at Enron, its affiliates, and subsidiaries are duty-bound to conduct business affairs honestly and ethically, and in keeping with all relevant laws (Enron Case Study PDF). The chairman further indicated that this ethical code contained policies which the organization and its directorial board approved, and which were responsible for its reputation as an honest, respectable and fair business entity. The ethics code further specified that employees ought not conduct themselves in a way that indirectly or directly proves harmful to Enron's best interests, or brings financial gain to employees, derived separately as a direct result of their employment with Enron. It is surprising how, given Lay's open commitment to conducting business ethically and the company's ethics/conduct code, the company suffered such a dramatic collapse, going from its reported 2000 revenue of 101 billion dollars and roughly 140 billion dollars in the next year's first 3 quarters, to bankruptcy by year-end (Enron Case Study PDF).

Background Leading to Issue

On 16th October, 2001, Enron Corporation announced its decision to take a 544-million-dollar after-tax fee against earnings linked to dealings with LJM2 Co-Investment, L.P.; this partnership was forged and overseen by Fastow (Enron's former Executive Vice President

and Chief Financial Officer). Furthermore, it announced a 1.2-billion-dollars decrease in shareholder equity linked to trade with the same partnership (Enron Background Statement for Case Study PDF). Not even 30 days had passed and the company issued another worrisome announcement that -- owing to accounting errors connected with its dealings with the limited partnership, LJM1(another Fastow partnership) and related-party business entity, Chewco, it was going to restate its 1997-2001 financial statements. Kopper, an employee of Enron Global Finance, whose immediate superior was Fastow, was charged with managing Chewco. The restatement, just like the previous reduced shareholder equity and fee against earnings, was extremely large. The total reported earnings/profit of Enron Corporation were reduced in this restatement by whopping amounts of: 28 million dollars in the years 1997 (of a total of 105 million dollars), 133 million dollars in the year 1998 (of a total of 703 million dollars), 248 million dollars in the year 1999 (of a total of 893 million dollars), and 99 million dollars in the year 2000 (of a total of 979 million dollars). Reported shareholder equity was reduced in the restatement by sums of 258 million dollars (1997), 391 million dollars (1998), 710 million dollars (1999) and 754 million dollars (2000). The restatement showed a 711-million-dollar debt rise in the year 1997, 561 million dollars in 1998, 685 million dollars in the year 1999, and 628 million dollars in 2000. Also, the company declared, for the first time, the fact that it discovered that Fastow earned over 30 million dollars from the limited partnerships, LJM1 and LJM2. All of the above announcements served to destroy investor trust and market confidence in Enron, and the company declared bankruptcy less than a month later (Enron Background Statement for Case Study PDF).

Business Matters/Stakeholders (Those Responsible for Collapse)

Enron is thought to have an organizational culture of overconfidence, which led the company to believe it could deal with increasingly greater amounts of risk easily and overcome any danger. Sherron Watkins states that Enron Corporation's unspoken instruction to employees was to do nothing but make numbers; stealing or cheating was fine as long as one wasn't caught. However, if one did, all one had to do was beg for another chance, which would be offered. In short, the corporate culture of Enron hardly promoted the important values of integrity and respect. Rather, it undermined them, through its stress on decentralization, as well as its employee compensation program and performance appraisal system (Enron Case Study PDF). The company's compensation plan was apparently focused on enriching company managers and not on generating shareholder profit. It encouraged employees to inflate contractual value despite lack of real cash generation, and break rules. Its bonus program promoted inflated deal valuation on Enron's books and the adoption of non-customary accounting practices. In fact, the former practice became a widespread occurrence at Enron; partnerships were created for the sole purpose of hiding losses and avoiding the repercussions of accepting responsibility for problems (Johnson, 2003).

Officials at Enron manipulated data for protecting personal interests and deceiving the public (of its dividends and shares); however, the depth of their dishonesty is yet to be explored fully. Board members as well as executives maintain that they had no clue regarding the depth of Enron's limited partnerships forged and managed by Kopper and Fastow, which did not appear in its official financial records. However, both Lay and Skilling were possibly aware of the suspicious nature of their organization's accounting tactics. The Permanent Subcommittee on Investigations -- a division of the United States Senate's Committee on Homeland Security and Governmental Affairs -- which looked into the issue of Enron's collapse, reached the conclusion that the board was well aware of most of the wrongdoings at Enron and problems it faced. Board members purposely dispensed with the clause on "conflicts of interest" in Enron's ethical code, which would have effectively prevented the forging of the aforementioned troublemaking special limited partnerships (Johnson, 2003). Company personnel quickly followed the top executives' lead. They started hiding expenses, claiming nonexistent profits, and deceiving energy regulators, among other things. Officials of the corporation behaved irresponsibly and failed to take requisite action, exercise appropriate oversight, and accept responsibility for Enron's ethical miscues. The Chief Executive downplayed the timely warnings he received of financial irregularities and some of the board members could not comprehend corporate operations or numbers. Frequently, employees were left to take important decisions by themselves; managers encouraged them to just make numbers by hook or crook. Following Enron's total collapse, not a single individual came forward to bear the blame for its downfall. When asked to answer to congressional committees, Fastow and Lay decided to claim 5th Amendment privilege against forced self-incrimination. While Skilling testified, he asserted that he was clueless of any illegal activity within the corporation. Enron officials decided to first be loyal to themselves, rather than to other company stakeholders, namely, stock holders, rate payers, business partners, foreign governments, local communities, etc. Furthermore, they broke employees' trust. Employees were led to believe the CEO's optimistic declarations. For instance, in August of 2001, Lay stated that he had never felt more optimistic about Enron's prospects. The very next month, only a few weeks prior to Enron's total collapse, he urged personnel to take up its stock, as Enron was fundamentally sound. Lay continued these exhortations even while unloading his personal shares (Johnson, 2003). Enron employees were not only betrayed, but lost their jobs as well as retirement savings.

The company's relationships with internal as well as external stakeholders were characterized by glaring inconsistencies. The average employee was coerced into vesting his/her retirement plan in company stock and, in the critical period when stocks were rapidly declining, was not allowed to sell his/her shares. Meanwhile, top management could unload its shares whenever it desired. Also, while 500 officials were given "retention bonuses" equaling 55 million dollars, laid-off employees received a small percentage of their severance pay. The company accorded royal treatment to its friends (Johnson, 2003). It utilized political donations, in particular, for gaining special treatment from governmental agencies. Enron was the highest contributor to George Bush's campaign; furthermore, company officials made substantial donations to Republican as well as Democratic Senate and House members. In exchange for these contributions, Enron could nominate its friends as candidates for FERC (Federal Energy Regulatory Commission) and SEC (Security Exchange Commission). Federal officers intervened with governments from other nations to promote the company's projects, while representatives of the company contributed significantly to instituting a national energy policy in favor of deregulation of added energy markets. Meanwhile, any individual/entity believed to be unfriendly to the company's interests would receive retribution. In one case, Enron's CEO pulled out of an underwriting agreement, in order to pressurize banker Merrill Lynch to fire an analyst responsible for downgrading Enron's stock (Smith, & Raghavan, 2002). In one conference call, Skilling swore at an analyst who questioned Enron's performance.

Right from the start, accounting company Arthur Andersen was Enron's external auditor. A couple of years after Enron's collapse, this leading international accounting firm that employed 36,000 individuals closed down. In the course of its 16-year-long association with Enron Corporation, Arthur Andersen provided Enron consulting and internal auditing services, in addition to external auditing. Between 1997 and 2001, Enron exaggerated its revenues by no less than 568 million dollars, which was 20% of its earnings for that period. Andersen auditors aided Enron in hiding this manipulation of earnings. On 15th June, 2002, the accounting firm was found guilty of obstructing justice by shredding Enron's audit documents (Arthur Andersen v. United States, 2005).

Enron's founder, chief executive, and chairman, Kenneth Lay proved to be a deceitful individual who lacks integrity, as is evidenced by the facts mentioned above. Under his guidance, the company engaged in fraud, and investors ended up losing several billion dollars. Another key individual held accountable in this case is Enron's Chief Operating Officer and President, Jeffrey Skilling, who also held the CEO's post for a brief period, between February and August 2001. Skilling testified to being innocent, which he clearly wasn't. On 14th August, 2001, Skilling, stating his desire to devote more time to his family, left Enron without making any of its financial problems known. However, on 17th September, 2001, he sold a whopping 500,000 shares. Prior to his departure, Skilling also indulged in unethical actions (Wang, 2012). Andrew Fastow, Enron's chief financial officer, is the third individual incriminated in this case. Fastow was directly to blame for the fiasco Enron witnessed, having manipulated financial numbers. Enron's audit partner, David Duncan, is liable as well. When faced with a dilemma, he chose personal gain and violated auditing standards, hence, contributed to fraud. The last and most important individual involved in this case is Enron's corporate development vice president, Sherron Watkins, who is the epitome of an ethical executive. She revealed Enron's financial situation to the public, by developing a memo disclosing Enron's financial situation, thereby risking her job. Despite being sure she would be out of a job soon, Watkins merely started seeking another job, while preparing reports for the public.

Aftermath of the Collapse

Enron Corporation's ethical code and foundational, core values of integrity, communication, excellence and respect failed in creating an ethical climate at Enron. Legal proceedings are still on, and the full explanation and extent of the organization's ethical collapse remains unknown. No less than 14 other employees of Enron (many of whom were at high-level positions) have been found guilty and accepted the various charges made against them; of these, twelve await sentence, and two (including Andrew Fastow's wife) have been sentenced to a minimum of one year in jail (Enron Case Study PDF). Five individuals have been charged with fraud by juries, as has Arthur Andersen, which shares responsibility for Enron's falsified accounting statements. Of the condemned individuals, 3 were employed at Merrill Lynch and were involved in a Nigerian agreement with Fastow. Skilling, Lay and the chief accounting officer of Enron, Richard Causey, await trial. Skilling, Causey and Lay face thirty-five, thirty-one, and eleven criminal charges, respectively. Five Enron Broadband executives await trial as well (Enron Case Study PDF). Also, three British banking executives embroiled in a complex set of agreements in one of the infamous Fastow partnerships, are fighting deportation. Additionally, the federal case against Skilling and Lay has no less than 114 unindicted conspirators.

Various Resolution Options

Enron's issue portrays the need to improve financial disclosure procedures. Programs should, perhaps, be instituted for replacing the current AICPA (American Institute of Certified Public Accountants) peer review procedure. At the very least, this case appears to demonstrate that the FASB (Financial Accounting Standards Board), responsible for making rules in this field, ought to establish more direct standards and regulations, which can be understood by ordinary people. More reliable public servants are required, rather than more regulations. The Private Securities Litigation Reform Act of 1995 slackened restrictions that would have curbed the behaviors leading up to Enron's scandal and destruction (What Really Went Wrong with Enron?). Nevertheless, government officials are now demanding more laws, which is apparently a ploy for turning the attention of the public from what policymakers have done to legislation, already. For instance, the Democratic Party representative from Ohio State, Dennis John Kucinich, formerly mayor of Cleveland, who was virtually single-handedly accountable for Cleveland's 1978-79 bankruptcy issue, is seen drafting legislation for creating an independent organization for the purpose of auditing public companies. Are another governmental office and more legislation really needed? What about already existent laws and their enforcers? Proposals like the one put forward by Kucinich appear to be diversions for protecting politicians. I personally feel politicians must be held responsible for their actions, and not just the businessmen (of questionable integrity). Moreover, the Enron case demonstrates a need for amending rather than banning non-audit works. Of late, auditing companies are being pressured to quit providing non-audit service (What Really Went Wrong with Enron?). Nevertheless, people fail to see that a number of key non-auditing services are actually very closely associated with audited information, and banning auditors from offering them makes no sense. One example of such a service is tax advice. Auditors are familiar with financial records of companies, so giving them tax advice seems the sensible thing to do.

Utilitarian philosophers John Stuart Mill and Jeremy Bentham contend that, resolving ethical issues necessitates balancing, wherein the harms resulting from a particular decision are minimized even as its benefits are maximized. In utilitarianism, decision-makers need to take into account the interests of every party impacted by the decision. Actions that maximize benefits must be chosen. Decision makers need to do as much good as they possibly can. They face the ethical quandary of protecting personal interests with foreseen harm to investors, or simply protecting a majority of stakeholder interest while sacrificing personal short-term interests. The answer for followers of utilitarian theory is obvious. Immanuel Kant and Categorical Imperative theories clearly state that one cannot exploit others and gain a one-sided benefit. Also, managers can employ the test cited in Spencer Johnson and Ken Blanchard's The One Minute Manager, which is to ask oneself three questions when deciding upon a course of action: 1) Is the action legal? 2) Is the action balanced? And 3) How does it make one feel? Enron employees ought to have considered these three questions (Wang, 2012). If I was employed with Enron, this is how I would answer those questions: First, according to some threads or my business intuition, I sense that the company is committing fraud. Helping anybody hide fraud is illegal. Secondly, disclosing such information to the public would get me fired. But hiding such important information will cause more people (i.e. company stockholders, investors, etc.) to suffer. Thirdly, I must expose this illegal activity to public as well as try to put a stop to it, despite the possibility of losing my job. I will feel guilty if I hide facts and let others suffer as a result.

Best Option for Resolution and Worst Option

The plan mentioned below will probably be the best resolution alternative for Enron:

Improving the MD&A (Management Discussion and Analysis) part of disclosure documents is deemed to prove valuable. MD&A has the following related goals (Pitt, 2002):

To present investors with a narrative account of the financial statements of companies, so that they can view companies from management's standpoint;

To make financial disclosure better on the whole, and offer a context for analysis of financial statements; and To present information regarding risks to, and quality of, organizations' cash flow and earnings

MD&A forms the mainstay of organizations' disclosures. It aims at wrapping GAAP (Generally Accepted Accounting Principles) financial statements up in an understandable, clear-cut discussion of context.

Investors must have increased awareness of financial statement sensitivity to the techniques, estimates, and assumptions based on which they are prepared. In its issue published on 12th December, 2001, the U.S. Securities and Exchange Commission (SEC) requested organizations to start addressing this need. The goal is adoption of new rules for eliciting more accurate and consistent disclosures with regard to crucial accounting policies within MD&A sections of companies' registration statements, information and proxy statements, and annual reports, with quarterly disclosure updates. Key accounting rules and policies need to include, at the very least, fundamental disclosures required by investors for understanding how corporations identify these policies, as well as a policy discussion bearing in mind companies' financial outcomes, which explains which accounting assumptions and estimates concern them. Investors profit from being aware of the uncertainties capable of affecting these assumptions and estimates (Pitt, 2002). The investors must be able to understand the economic substance and business purpose of a transaction, special contingencies, or risks associated with it, and its impacts on financial statements. Investors will also profit from more specific requirements for MD&A pertaining to the impacts of such transactions.